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Owen Bernard
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  • Complete list!! w/back-of-the-envelop Analysis on Top Company 0 comments
    Aug 18, 2011 6:38 PM | about stocks: ARO, WDC, SUNE, BBRY, NOK, TSL, LPS, LMT, TOT, PTI, CALM, FRO, FWLT, LXK, GAP, JASO, HPQ, RDS.A, RDS.B, RTN, AMED, DLX, IACI, GD, AEO
    Here is the complete list of companies I generated for the Tier 3 group and think you will still find the companies on the list to be a bit of a bargain still.
     


    Going through the list you would find that the Aeropostale(ARO) is top of the list leading all other ideas. 

    To give an idea of a back-of-the-envelop analysis, I would work through ARO considering factors of what is the downside then a quick assessment of the upside.

    Downside

    For ARO downside you have to change hats for a minute and think of yourself as a banker trying to capture business from ARO. The company holds no interest-bearing debt and has roughly $73m in cash and equivalents. The 26 week 2011 oper. inc. is roughly $33m. Using 2010 2nd half oper. inc. of $240m, we have a starting point to consider what portion of operating earnings is sustainable to consider the safety of our loan to ARO. With $273m of ttm oper. inc. I would consider $68m a sustainable portion of those earnings in spite of the current issues the company is going through. Corporate bonds for 5 yr. AAA, AA, A are yielding 1.45, 2.31 and 2.79 looking on yahoo! finance. Using the yields to capitalize the $68m, we are at a per share face value for the bonds ranging in value from $29 to $56. Certainly the ranges are a bit absurd so I would capitalize $68m at different rates.

    6% cap rate gives a bond per share face value of  $13
    8% "     "      "      "    "       "     "       "     "     "   $10
    10% "    "      "      "    "      "      "        "   "      "  $8

    Now, to put yourself in the shoes of the company chairman and ceo. If they wanted to unlock value for the company they can take the approach of issuing 1st lien debentures to shareholders who seem to be looking for a bit of certainty. With $68m representing only a quarter of the pre-tax oper. inc. of $273 it is certainly a quick way to began looking at where our margin of safety lies. 

    Upside

    Predictions are difficult, especially about the future" - physicist Niels Bohr

    The EBITDA multiple for J Crew Group was 8.9 based on 2010 estimate The link below is the SC 13E3 going private filing with the Security & Exchange Commission. There are other filings in relation to the transaction that Goldman Sachs conducted for J Crew's industry peers.

    http://www.sec.gov/Archives/edgar/data/1051251/000119312510274122/dex99c2.htm

    http://www.sec.gov/Archives/edgar/data/1051251/000119312511010576/dprer14a.htm#toc140006_13

    EBITDA has limited uses (well explained in Moody's research 
    "Putting EBITDA in Perspective: Ten Critical Failings Of EBITDA As The Principal Determinant of Cash Flow")
     as they were apparent in the early 90's junk bond fiasco, so to go any further on a valuation based solely on this metric would be misinformed. Discounted Cash Flow models are bit flawed but considering a similar concept maybe well suited. To bring the concept into perspective, the question "What rate would a rational creditor capitalize ARO's sustainable earnings and what portion of those earnings?" is best answered by considering normative pretax margins and taking into account a third of the pretax earnings as a viable option going forward. Normalizing the earnings is a bit more grounded which I base on historical rates and less on forward looking assumptions. With EBITDA limited in giving a sound basis for Enterprise Valuations, I find ARO's pretax earnings with no interest expense a better alternative to anchor minimum valuations considering what a rational intelligent creditor is willing to finance.

    Given the range of valuation methodologies, ARO is fairly undervalued with respect to weightings on the range of expected values. There is certainly a risk for a potential drop in price in the near future(nothing unexpected) but risk-reward ratio is potentially attractive at the current market price.

    Other Helpful Research
    http://www.moodyskmv.com/research/files/wp/66988.pdf

     
    Stocks: ARO, WDC, SUNE, BBRY, NOK, TSL, LPS, LMT, TOT, PTI, CALM, FRO, FWLT, LXK, GAP, JASO, HPQ, RDS.A, RDS.B, RTN, AMED, DLX, IACI, GD, AEO
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